Investors looking for a bargain in the banking sector might be attracted to Ally Financial's (ALLY -1.25%) shares, which are trading down roughly 50% from their 2021 highs. Ally's dividend yield is now 4.3%, which is toward the high side of its historical yield range, hinting at a cheap entry point.
But before you make a final call with this digital-heavy bank, you might want to consider industry giant Toronto-Dominion Bank (TD 0.64%) instead. Here's why.
Size matters among bank stocks
There's nothing inherently wrong with smaller banks, but the depositor runs seen at several banks in early 2023 are something of a wake-up call. Smaller banks do, in fact, have more risk when there are industry dislocations. Ally Financial has a market cap of roughly $8.5 billion. TD Bank, which is the more common name used for Toronto-Dominion, has a market cap of around $105 billion.
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To look at this a different way, Ally Financial describes itself as a "top 25" U.S. financial holding company. TD Bank is the largest bank in Canada by deposits and the fifth-largest in the United States. While smaller companies may find growth easier to come by, given the smaller base, larger banks usually offer more financial safety.
Credit rating agencies set the standards
Don't take that last statement at face value. Challenge it by examining what the large credit rating agencies say. Ally Financial has earned an investment-grade credit rating of BBB- from Standard & Poor's. TD Bank's credit rating from that same agency is A, placing it higher up in the investment grading universe. In fact, Ally is just one rating step away from being below investment grade, or the range commonly referred to as junk.
Pick banks that are ready for adversity
Adding to the safety of TD Bank is its Tier 1 Capital Ratio, which sits at 15.5%. The Tier 1 ratio is, effectively, a measure of how well a bank is prepared for adversity. Higher numbers are better. Ally's Tier 1 ratio is 10.7%. Notably, TD Bank's Tier 1 ratio is the second highest in all of North America.
To be fair, the ratio is so high because TD Bank was planning on an acquisition that didn't happen. But, given the current banking and economic backdrop, having a higher Tier 1 ratio seems like a net positive.
More yield, but at a cost
As noted above, Ally's dividend yield is around 4.3% today. TD Bank's yield is just shy of 5% (it's up because the acquisition that didn't happen depressed the stock price). TD Bank is based out of Canada, so U.S. investors will have to pay Canadian taxes on the dividend they receive, but those taxes can be claimed back come April 15. Also, the dividend is paid in Canadian dollars, so the actual dollar value will change along with exchange rates. But the extra 60 to 70 basis points in yield you'll collect will likely more than make up for any hassle related to TD Bank being Canadian.
Efficiency ratios are comparable
One area where Ally comes out ahead is the efficiency ratio, which is a measure of how well a bank controls its expenses. Ally's adjusted efficiency ratio was 55.8% in the first quarter of 2023. TD Bank's ratio was 53.4% in the fiscal second quarter of 2023, which is the comparable time period.
There are some caveats here, though. Ally has a heavy focus on digital; TD Bank's business is relationship based and focused on brick-and-mortar locations (of course it also offers online banking to its customers, for their convenience). Also, as a larger company, TD Bank has a lot more going on, including operations in areas where Ally doesn't play. That suggests that more inefficiencies will naturally creep into the picture. In the end, this one number isn't enough to overshadow all of the others, and TD Bank should be good enough here to pass muster with most investors.
The higher yield wins
All in, TD Bank and its higher dividend yield are probably a better option for most investors when compared to Ally Financial. That's not to suggest that Ally Financial is a bad company, just that TD Bank looks more attractive given its size and financial strength. If you are a dividend investor looking at Ally and considering its historically high yield, the comparison with TD shows that there are other options that might be a better fit.
